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April 23, 2015

Tax History: Liberals Should Talk About Horizontal, Not Vertical, Equity

Joseph J. Thorndike

For a party obsessed with tax fairness, Democrats do a remarkably bad job of talking about it. After all, they have the wind at their backs: Polls reveal deep skepticism about the tax system's basic fairness, as well as broad concern about growing inequality.

But Democrats tend to confuse these general worries with more specific support for redistributive taxation. In fact, skepticism and insecurity are not a license to soak the rich. Rather, they point to more traditional forms of tax reform, with an emphasis on horizontal rather than vertical equity.

Historical Trends

Historically, Americans have been dubious about redistributive tax policies. They have, of course, endorsed progressive tax reform, both directly through opinion polls and indirectly through their voting preferences. A look back at marginal tax rates confirms that Americans have always liked their taxes to be progressive -- sometimes very progressive.

But there is less to that evidence than many of today's Democrats seem to think. Some of it can be explained by inertia. I've long suspected, for instance, that the longevity of the estate tax was a demonstration of path dependency; it was on the books almost from the start, so it stayed on the books for the rest of the 20th century.

Moreover, at the federal level, many of the tax system's most progressive elements were originally sold as a way to redistribute the tax burden, not wealth or income. The estate tax in particular was about making sure that rich people shouldered enough of the overall tax burden. Sure, it was also endorsed by politicians warning darkly of the dangers posed by dynastic wealth. But for the most part, the estate tax was defended as a tool for tinkering with the tax burden, not for remaking the socioeconomic underpinnings of American society.1

The same is true of corporate and individual income taxes. The corporate tax was generally viewed as a tax on wealthy shareholders (despite long-standing uncertainty about the levy's actual incidence). High marginal rates on individual income were similarly cast as a means to ensure that fiscal burdens were shared equitably across the populace.

Vertical equity has always been important in U.S. tax debates. But it has not, generally speaking, been the linchpin of progressive tax reform. That distinction belongs to horizontal equity. Americans were complaining about "loopholes" long before Stanley Surrey rebranded them as tax preferences.

Many politicians -- including some of the most successful liberal ones -- have understood the power of horizontal equity when marshaled in the defense of progressive reform. In fiscal debates, for instance, Franklin Roosevelt is often recalled for his famous Wealth Tax Act of 1935, but he should also be remembered for the anti-loophole campaign of 1937, which emphasized the progressive payoff that comes from repairing the tax base. Roosevelt understood that base broadening had a natural constituency among voters who believed they were paying "their fair share" while others were not.

Roosevelt (and like-minded liberals in other periods) often managed to leverage popular outrage over tax avoidance to advance more general progressive tax reform. The sense that other people are getting away with murder has long been a powerful tool of political mobilization.

Pew Study

And apparently, it still is. According to a recent poll from the Pew Research Center, 59 percent of Americans think "there is so much wrong with the federal tax system that Congress should completely change it."2 The problem, however, isn't that people think they're paying too much; only about one-quarter of all respondents said they were unhappy with the amount that they had to send the IRS.

Rather, people were unhappy about tax avoidance -- or at least the nagging suspicion that tax avoidance was going on. According to the Pew survey, 64 percent of Americans are bothered "a lot" by the thought that some corporations don't pay "their fair share." Similarly, 61 percent are concerned that rich taxpayers aren't paying their fair share, either. By contrast, only 20 percent are bothered by the prospect of poor people shirking their fiscal responsibilities.

(Incidentally, let's dispense right now with complaints about the "fair share" language. Yes, it's malleable and devoid of concrete meaning, but that's because fairness is a social construct, which is why we ask poll questions about it. In politics, opinion matters -- even when it's uninformed, misinformed, or just plain stupid.)

Fair share worries eclipse all other complaints about the tax system. Among those respondents concerned about more than one issue of tax fairness, 28 percent said they were most bothered by corporations avoiding their fair share, while 25 percent said the same thing about individuals. Complexity, by contrast, bothered just 19 percent, followed by 7 percent who pointed to the amount they were required to pay. Just 4 percent said tax avoidance by the poor was the biggest problem facing the tax system.

Liberal Opportunity

The Pew survey suggests that liberals should be careful about how they frame their tax proposals. In particular, they should tread lightly around the issue of inequality. Americans are indeed worried about rising wealth and income disparities. And many seem inclined to blame the tax system for the trend. In another Pew study from last year, respondents were asked about the causes of inequality. About 20 percent cited tax loopholes or a general bias in the tax system toward wealth as the leading cause of it. In fact, that answer topped all others.3

That's good news if you're a progressive Democrat. But it's not clear that those sorts of numbers translate into higher taxes on the rich -- at least if "higher taxes" is taken to mean higher rates. Americans view inequality as a problem, but they don't seem convinced that government is the answer.

As Neil Irwin recently observed in The New York Times, middle-income wages have been stagnant for decades, while higher incomes have increased dramatically. But over that same period, support for redistributive fiscal policies -- and especially higher taxes -- has been largely unchanged. "In other words, Americans' desire to soak the rich has diminished even as the rich have more wealth available that could, theoretically, be soaked,"4 observed Irwin.

That seems like a puzzle, but it's not that hard to explain. Americans simply don't see new taxes as a remedy for social problems. Rather, they see old taxes as a cause of social problems, or at least a contributing factor. What they want is not some sort of new tax to fix inequality, but a repair of old taxes so they won't contribute to inequality.

Liberals shouldn't be afraid of that conclusion: There's plenty of progressive work to be done under the rubric of horizontal equity. To begin with the most obvious, they could target the tax preference for capital gains. The carried interest controversy is an element of that broader debate, but it really distracts from the central point: Any sort of capital gains preference is a compromise with traditional norms of horizontal equity.

Moreover, even the estate tax could be defended as a tool for ensuring horizontal equity. Liberals should spend less time talking about how few people are paying the estate tax and more time emphasizing how many unrealized gains are never taxed by any other fiscal instrument. (In a recent blog post, my colleague Clint Stretch actually suggested that the estate tax be replaced by a new tax on "untaxed wealth being transferred to others," which would put the horizontal equity argument front and center.5)

Indeed, the estate tax could be the fulcrum of liberal rethinking when it comes to progressivity. Efforts to defend the estate tax on the basis of inequality and anti-dynastic social engineering have been a notable failure. Liberals should use that failure to reassess the political resonance of both vertical and horizontal equity. If history is any guide, I think they'll find that the latter wins more votes.